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Should You Avoid Highly Valued Companies Like AO World PLC And Boohoo.Com PLC?

AO World (LSE: AO) and Boohoo.Com (LSE: BOO) two of the market’s hottest growth companies and both companies have attracted plenty of attention since coming to market last year. 

However, these companies are not suitable for all investors as their high valuations and inflated expectations can lead to volatile trading. As a result, many investors will choose to stay away, but are these companies suitable for your portfolio?

High valuations 

Many investors and analysts alike are concerned about the high valuations of AO and Boohoo, and it’s easy to see why.

Indeed, at present levels and according to current City forecasts, AO World currently trades at a forward P/E of 247 and a projected 2016 P/E of 62. Similarly, Boohoo trades at a forward P/E of 26. 

For any value investors, these valuations are clearly a red flag. There are plenty of other opportunities out there, trading at a more attractive valuations. In addition, these high valuations don’t leave much room for error and if things go wrong, like they did last week when Boohoo warned on profits, valuations can quickly fall back to earth. 

Still, both Boohoo and AO World are two cash generative, profitable, high growth, high margin businesses and these traits are worth paying a premium price for. For example, Boohoo’s earnings per share are expected to double over the next two years, while AO World’s earnings are set to jump by around 500% by the end of 2017. 

Sales growing 

AO World’s third quarter trading update, released today, seems to support City expectations for growth. Website revenue rose 38% during the group’s fiscal third quarter, which includes the key Christmas trading period and Black Friday. However, these figures exclude AO World’s new German operations, launched ahead of plan. According to management, sales in this division are already growing rapidly. 

What’s more, AO World is leading the industry in terms of website response times, service levels and logistics performance, in spite of the chaos caused by the Black Friday sales, which overwhelmed many retailers. 

But high expectations for growth come with the increased risk of disappointment. Growth stocks disappoint all too often and the ensuing volatility can sometimes be too much for some investors to handle.

With this in mind, growth stock with a high valuations, such as AO World and Boohoo are not suitable for all investors. While they are attractive, there’s plenty of risk and their outlook can change rapidly. 

The bottom line 

So overall, there’s no need to avoid companies like AO World and Boohoo completely but you need to understand the risks before investing.  

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Rupert Hargreaves has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.